The comprehensive tax reforms under discussion in Washington include a subject of great importance to farmers — the cash method of accounting.
The cash method is used by many taxpayers in addition to farmers, specifically service businesses and professional practices.
But there are important differences for ag producers to articulate to lawmakers if they are going to avoid getting swept away by the tide of Washington’s thirst for more tax revenue.
Under the cash method, income is only recognized when sale proceeds are collected. Deductions are claimed when payment is made. The major exception for ag producers is animals purchased for resale. The cost of feeder pigs and feeder cattle, for example, must be held until the sale occurs.
Depreciable property is another exception; the Section 179 deduction and other depreciation is claimed when the asset is purchased and available for service, even though the entire cost might be financed.
Ag producers whose primary activity is raising and growing plants and animals are eligible for the cash method. There are no upper dollar limits for those organized as proprietorships, partnerships, or S corporations. But C corporations in agriculture are forced to the accrual method at $1 million of gross receipts if they have widely held investor ownership, but not until $25 million if members of one family own at least 50% of the stock.
By comparison, the only other taxpayers who can use the cash method are service businesses that do not vend goods. This includes medical providers, attorneys, accounting, engineers, and other professionals, as well as many other small businesses providing services. Ag producers are unique with respect to this privilege: Any other business producing or selling goods is forced to accrual.
THE ACCRUAL METHOD
When the accrual method applies to an ag producer, there are two significant ways in which income is accelerated. First, of course, are any deferred-payment sales. Commodities sold in October for payment in January become this year’s income, not next year’s. But also, and often of greater consequence, unsold inventory at year-end must be valued and taxed. This second aspect is where the real damage would occur. It’s one thing to accelerate the taxation of a receivable where that actual amount of cash will be collected in a few months. But taxing unsold livestock and grain, where the value at Dec. 31 might be greater than its sale price six months or a year later, would cause real havoc.
This is the point that needs to be conveyed clearly in Washington.
Farmers may look like other producers in the sense that making cartons of widgets, pounds of pork or bushels of grain are all essentially manufacturing processes. But ag producers have widely fluctuating commodity prices, not to mention the variables of weather and disease on the quantity produced.
The academics argue that accrual provides a proper reflection of income, but the reality in agriculture is that it would lead to greatly fluctuating years of income and losses if applied for tax purposes.
Editor’s Note: Andy Biebl is a CPA and principal with the firm of CliftonLarsonAllen LLP in Minneapolis and New Ulm, Minn., and a national authority on ag taxation. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future columns, e-mail AskAndy@dtn.com.